A Family Office Blog

Quite a bit of the news cycle has lately been taken up by the new steel and aluminum tariffs signed into effect last week and the impact these policies may have on our trading partners. It seems for the moment that Canada and Mexico are going to be “exempt” since they are close “neighbors” with vibrant U.S. trade activity. A quick Google search indicated that the top five exporters of steel and aluminum to the U.S. were:

Steel Exporters to US

Aluminum Exporters to US

1. Canada

1. Canada

2. Brazil

2. Russia

3. South Korea

3. United Arab Emirates

4. Mexico

4. China

5. Russia

While China ranks 4th in aluminum it doesn’t even make the top five exporters of steel. In fact, China ranks 11th among the countries that export to the U.S. market. In reviewing a recent research report from one of our Emerging Market equity managers, Matthews Asia it became more clear as to the impact of these policies on China and some of the “false premises” of these policies.

First, one of the major talking points in favor of tariffs is China’s massive production capacity is being used to flood the rest of the world with cheap Chinese steel and aluminum. While China does account for 50% of the world’s steelmaking capacity, it also consumes an astounding 90% of what it produces. Put another way, they consume a total of 45% of the world’s steel on an annual basis. It is also worth noting here that China exports only 7.2% of its total steel output, and that this figure has been declining for several years and it is expected to continue to do so. The production and consumption statistics show a very similar story but are even more pronounced. China produces a total of 55% of the world’s aluminum, of which it consumes 96%. Here also exports are down, more than half of their peak value in 2007. Will an export tariff of 25% meaningfully impact these numbers?

The second argument used in support is that tariffs such as this will impact the Chinese economy and force an internal policy change by their government. The data however does not back up this claim. The total value of all steel and aluminum exported to the U.S. by China equaled only 0.03% of Chinese GDP in 2017. It would not be rational for any government to make significant policy changes due to such a minimal tax on such a minimal part of their economy. The Chinese should, and most likely will, continue to produce as much of these metals as they need in order to fuel their own internal growth, a feat which will implicitly help the U.S. through increased demand for those assets we do export in today’s economy, services and intellectual property.

In short, the data does not suggest that these new tariffs will do anything to meaningfully change the way China produces its steel and aluminum. The economic impact of their exports to the U.S. are just too small for either country to notice. On a more political note, perhaps the recent visit to the White House by the South Koreans had some to do with petitioning the Trump Administration for tariff relief on their steel exports to the U.S. More on this story later.

Wow, what a February! Following the peaceful performance of the prior 15 months, market craziness (called volatility) returned to our investment lives last month. Sweaty palmed traders and news commentators seemed hell bent on scaring investors to death. Last month finally ushered into our world the sell-off that had been much discussed. The pundits who appeared to have been “crying wolf” finally got it right.

To be clear, though, February was not an anomaly for the market. It was merely a return to the norm. Over the last 80 years there has been an average of three pull backs in the market each year of 5% or more. There is, on average, a 10% correction in the market every year, and a 15% correction every two years. We have not had a 15% pull back since 2011. The multiple market moves of hundreds of points in February looked frightening in the headlines, but remember a 240 point move is only a 1% change when the market is at 24,000. Last month was really just a return to business as usual.

So given we are back in a normal market where volatility is to be expected, what major drivers should investors focus on during this bumpy trip. Below are six observations:

The quality of earnings of companies does matter.

When the economy is doing well, the Fed will tend to raise rates.

When consumers feel some security in their job, they spend money.

Corporate tax cuts will have multi-year benefits to companies and shareholders.

What is happening in Washington DC probably matters more in the short run than in the long run.

Short-term rates are going up. Savers will be happy and stock investors will worry.

The market is considering the likely behavior of investors as rates rise. We have seen short term rates go up by 75 basis points this past year, and a further rise 75 basis points is predicted for the rest of the year. We are getting close to a time this year when investors can earn a return of 2% on treasury bills. This might cause some equity investors to question their long-term commitment to owning stocks. It strikes me that the singular biggest risk to the current market is the way investors will adjust to higher rates. The fundamentals would suggest that, from an earning perspective, there should be little to worry about, but all markets are driven to a great extent by emotion, and especially by worry.

The person responsible for orchestrating this return to higher interest rates is the new head of the Federal Reserve, Jerome Powell. The last two Fed Chairpersons proved to be very adept at conducting the orchestra of the market through uncertain times. Time will tell if the new maestro will be able to wield his baton with the same positive outcome.